In Class Problem Solving 3

1. Most financial decisions involve two related elements:

a. advice and consent.
b. investment and taxes.
c. time and risk.
d. saving and consumption.
ANS: C
2. The field of finance primarily studies
a. how society manages its scarce resources.
b. the implications of time and risk for allocating resources over time.
c. firms decisions concerning how much to produce and what price to charge.
d. how society can reduce market risk.
ANS: B

3. Which of the following statements best describes the economists view of finance and the financial system?
a. The financial system is very important to the functioning of the economy, and the tools of finance
are often helpful to us as individuals when we find ourselves making certain decisions.
b. The financial system, while interesting, is not very important to the functioning of the economy;
however, the tools of finance are often helpful to us as individuals when we find ourselves making
certain decisions.
c. The financial system is very important to the functioning of the economy; however, the tools of
finance are not particularly helpful to us as individuals since we seldom make decisions for which
those tools are useful.
d. The field of finance is intimately concerned with the financial system and the tools of finance, and
financial economists see great importance in them; however, the mainstream economist sees
little value in studying financial markets or the tools of finance.
ANS: A
4. Suppose you put $350 into a bank account today. Interest is paid annually and the annual interest rate is 6
percent. The future value of the $350 after 4 years is
a. $414.09.
b. $434.00.
c. $441.87.
d. $481.24.
ANS: C
5. Suppose you put $500 into a bank account today. Interest is paid annually and the annual interest rate is 5.5
percent. The future value of the $500 is
a. $637.50 after 5 years and $822.09 after 10 years.
b. $637.50 after 5 years and $775.00 after 10 years.
c. $653.48 after 5 years and $854.07 after 10 years.
d. $688.36 after 5 years and $915.56 after 10 years.
ANS: C
6. If the interest rate is 7.5 percent, then what is the present value of $4,000 to be received in 6 years?
a. $2,420.68
b. $2,591.85
c. $2,996.33
d. $3,040.63
ANS: B
7. Suppose you will receive $500 at some point in the future. If the annual interest rate is 7.5 percent, then the
present value of the $500 is
a. $411.26 if the $500 is to be received in 5 years and $338.95 if the $500 is to be received in 10
years.
b. $348.28 if the $500 is to be received in 5 years and $242.60 if the $500 is to be received in 10
1
.

c.
d.
ANS:

years.
$291.11 if the $500 is to be received in 5 years and $272.89 if the $500 is to be received in 10
years.
$291.11 if the $500 is to be received in 5 years and $236.49 if the $500 is to be received in 10
years.

8. Compounding refers directly to

a. finding the present value of a future sum of money.
b. finding the future value of a present sum of money.
c. changes in the interest rate over time on a bank account or a similar savings vehicle.
d. interest being earned on previously-earned interest.
ANS: D
9. Discounting refers directly to
a. finding the present value of a future sum of money.
b. finding the future value of a present sum of money.
c. calculations that ignore the phenomenon of compounding for the sake of ease and simplicity.
d. decreases in interest rates over time, while compounding refers to increases in interest rates over
time.
ANS: A

10. A manufacturing company is thinking about building a new factory. The factory, if built, will yield the company $300 million in 7 years, and it would cost $220 million today to build. The company will decide to build
the factory if the interest rate is
a. no less than 4.53 percent.
b. no greater than 4.53 percent.
c. no less than 5.81 percent.
d. no greater than 5.81 percent.
ANS: B
11. Which of the following is the correct way to compute the future value of $X that earns r percent interest for
N years?
a. $X(1 + rN)N
b. $X(1 + r)N
c. $X(1 + rN)
d. $X(1 + r/N)N
ANS: B
12. Which of the following is the correct way to compute the future value of $1 put into an account that earns 5
percent interest for 16 years?
a. $1(1 + .05)16
b. $1(1 + .05 16) 16
c. $1(1 + .05 16)
d. $1(1 + 16/.05)16
ANS: A
13. Which of the following is the correct way to compute the future value of $100 put into an account that
earns 4 percent interest for 10 years?
a. $100(1 + .0410)
b. $100(1 + .04 10)
c. $100 10 (1 + .04)
d. $100(1 + .04)10
ANS: D
14. The future value of a deposit in a savings account will be larger
a. the longer a person waits to withdraw the funds.
b. the higher the interest rate is.
c. the larger the initial deposit is.

ANS:

d.

All of the above are correct.

15. Toni put $500 into an account and one year later she had $534. What interest rate was paid on Tonis deposit?
a. 7.1 percent
b. 5.9 percent
c. 6.8 percent
d. None of the above is correct.
ANS: C
16. Bert put $75 into an account and one year later had $100. What interest rate was paid on Berts deposit?
a. 20 percent
b. 25 percent
c. 28 percent
d. None of the above is correct.
ANS: D
17. Susan put $375 into an account and one year later had $405. What interest rate was paid on Susans deposit?
a. 5 percent
b. 7 percent
c. 8 percent
d. 10 percent
ANS: C
18. Hector puts $150 into an account when the interest rate is 4 percent. Later he checks his balance and finds
he has about $168.73. How long did Hector wait to check his balance?
a. 3 years
b. 3.5 years
c. 4 years
d. 4.5 years
ANS: A
19. Marcia has four savings accounts. Which account has the largest balance?
a. $100 deposited 1 year ago at an 8 percent interest rate
b. $100 deposited 2 years ago at a 4 percent interest rate
c. $100 deposited 4 years ago at a 2 percent interest rate
d. $100 deposited 8 years ago at a 1 percent interest rate
ANS: D
20. Which, if any, of the present values below are computed correctly?
a. A payment of $100 to be received one year from today, with a 2 percent interest rate, has a
present value of $98.81.
b. A payment of $200 to be received two years from today, with a 3 percent interest rate, has a
present value of $188.52.
c. A payment of $300 to be received three years from today, with a 4 percent interest rate, has a
present value of $234.34.
d. None of the above are correct to the nearest cent.
ANS: B
21. Risk aversion helps to explain various things we observe in the economy, including
a. adherence to the old adage, Dont put all your eggs in one basket.
b. insurance.
c. the risk-return trade-off.
d. All of the above are correct.
ANS: D

22. Economists have developed models of risk aversion using the concept of
a. utility and the associated assumption of diminishing marginal utility.
b. utility and the associated assumption of increasing marginal utility.
c. income and the associated assumption of diminishing marginal wealth.
d. income and the associated assumption of increasing marginal wealth.
ANS: A
23. For a risk averse person,
a. the pleasure of winning $1,000 on a bet exceeds the pain of losing $1,000 on a bet.
b. the pain of losing $1,000 on a bet exceeds the pleasure of winning $1,000 on a bet.
c. the utility function exhibits the property of increasing marginal utility.
d. the utility function gets steeper as wealth increases.
ANS: B
24. Matts Utility Function
Wealth
Utility
$50,000
7000
51,000
7250
52,000
7499
53,000
7746
If Matts current wealth is $51,000, then
a. his gain in utility from gaining $1,000 is greater than his loss in utility from losing $1,000. Matt is
risk averse.
b. his gain in utility from gaining $1,000 is greater than his loss in utility from losing $1,000. Matt is
not risk averse.
c. his gain in utility from gaining $1,000 is less than his loss in utility from losing $1,000. Matt is risk
averse.
d. his gain in utility from gaining $1,000 is less than his loss in utility from losing $1,000. Matt is not
risk averse.
ANS: C
Figure 1. The figure shows a utility function.

C
B
A

$400

$600

$800

Wealth

25. Refer to Figure 1. What is measured along the vertical axis?

a. risk aversion
b. marginal utility
c. Utility
d. the number of units of a good that can be purchased
ANS: C
26. Refer to Figure 1. The utility function that is shown exhibits the property of diminishing
a. wealth.
b. utility.

ANS:

c.
d.

marginal wealth.
marginal utility.

27. Refer to Figure 1. Which distance along the vertical axis represents the marginal utility of an increase in
wealth from $600 to $800?
a. the distance between the origin and point B
b. the distance between the origin and point C
c. the distance between point A and point C
d. the distance between point B and point C
ANS: D
28. Refer to Figure 1. Let 0A represent the distance between the origin and point A; let AB represent the
distance between point A and point B; etc. Which of the following ratios best represents the marginal utility
per dollar when wealth increases from $400 to $600?
a.
b.
c.
d.
ANS:

29. Refer to Figure 1. For the person to whom this utility function applies,
a. the more wealth she has, the less utility she gets from an additional dollar of wealth.
b. the more wealth she has, the more utility she gets from an additional dollar of wealth.
c. her level of satisfaction will be enhanced more by an increase in wealth from $600 to $800 than it
would be by an increase in wealth from $400 to $600.
d. her level of satisfaction will be enhanced equally by an increase in wealth from $600 to $800 or by
an increase in wealth from $400 to $600.
ANS: A
30. Refer to Figure 1. Suppose the person to whom this utility function applies begins with $600 in wealth.
Starting from there,
a. she would be willing to accept a coin-flip bet that would result in her winning $200 if the result
was heads or losing $200 if the result was tails.
b. the pain of losing $200 of her wealth would equal the pleasure of adding $200 to her wealth.
c. the pain of losing $200 of her wealth would exceed the pleasure of adding $200 to her wealth.
d. the pleasure of adding $200 to her wealth would exceed the pain of losing $200 of her wealth.
ANS: C
31. Refer to Figure 14-1. The properties exhibited by this utility function help to explain various things we
observe in the economy, including
a. the risk-return tradeoff.
b. insurance.
c. diversification.
d. All of the above are correct.
ANS: D
Figure 2. The figure shows a utility function for Mary Ann.

Utility
C
B
A

$750

$1,050

$1,350

Wealth

32. Refer to Figure 2. From the appearance of the utility function, we know that
a. Mary Ann is risk averse.
b. Mary Ann gains less satisfaction when her wealth increases by X dollars than she loses in
satisfaction when her wealth decreases by X dollars.
c. the property of diminishing marginal utility applies to Mary Ann.
d. All of the above are correct.
ANS: D
33. Refer to Figure 2. From the appearance of the utility function, we know that
a. Mary Ann is risk averse.
b. Mary Ann gains more satisfaction when her wealth increases by X dollars than she loses in
satisfaction when her wealth decreases by X dollars.
c. the property of increasing marginal utility applies to Mary Ann.
d. All of the above are correct.
ANS: A
34. Refer to Figure 2. Suppose the vertical distance between the points (0, A) and (0, B) is 5. If her wealth
increased from $1,050 to $1,350, then
a. Mary Anns subjective measure of her well-being would increase by less than 5 units.
b. Mary Anns subjective measure of her well-being would increase by more than 5 units.
c. Mary Ann would change from being a risk-averse person into a person who is not risk averse.
d. Mary Ann would change from being a person who is not risk averse into a risk-averse person.
ANS: A
35. Refer to Figure 2. From the appearance of the utility function, we know that
a. if Mary Ann owns a house, she would not consider buying fire insurance.
b. Mary Ann would prefer to hold a portfolio of stocks with an average return of 8 percent and a
standard deviation of 2 percent to a portfolio of stocks with an average return of 8 percent and a
standard deviation of 5 percent.
c. Mary Ann would prefer to hold a portfolio of stocks with an average return of 8 percent and a
standard deviation of 5 percent to a portfolio of stocks with an average return of 6 percent and a
standard deviation of 3 percent.
d. All of the above are correct.
ANS: B
36. Refer to Figure 2. Suppose Mary Ann begins with $1,050 in wealth. Starting from there,
a. she would be willing to accept a coin-flip bet that would result in her winning $300 if the result
was heads or losing $300 if the result was tails.
b. the pain of losing $300 of her wealth would equal the pleasure of adding $300 to her wealth.
c. the pain of losing $300 of her wealth would exceed the pleasure of adding $300 to her wealth.
d. the pleasure of adding $300 to her wealth would exceed the pain of losing $300 of her wealth.
ANS: C

37. Refer to Figure 2. Suppose Mary Ann begins with $1,050 in wealth. Which of the following coin-flip bets
would she definitely not be willing to accept?
a. If it is heads, she wins $100; if it is tails, she loses $95.
b. If it is heads, she wins $150; if it is tails, she loses $150.
c. If it is heads, she wins $150; if it is tails, she loses $140.
d. She definitely would not accept any of these bets.
ANS: B
Figure 3. The figure shows a utility function for Rob.

Utility

C
B
A

$500

$700

$900

Wealth

38. Refer to Figure 3. From the appearance of Robs utility function, we know that
a. the pain that Rob would experience if he lost $200 of his wealth would exceed the pleasure that
he would experience if he added $200 to his wealth.
b. the pleasure that Rob would experience if he added $200 to his wealth would exceed the pain
that he would experience if he lost $200 of his wealth.
c. the property of increasing utility does not apply to Rob.
d. the property of diminishing marginal utility does not apply to Rob.
ANS: D
39. Refer to Figure 3. From the appearance of Robs utility function, we know that
a. if Rob owns a house, then he definitely would buy fire insurance provided the cost of the
insurance were reasonable.
b. Rob would voluntarily exchange a portfolio of stocks with a high average return and a high level of
risk for a portfolio with a low average return and a low level of risk.
c. Rob is risk averse.
d. Rob is not risk averse.
ANS: D
40. Refer to Figure 3. If most peoples utility functions look like Robs utility function, then it is easy to explain
why
a. people buy various types of insurance.
b. we observe a trade-off between risk and return.
c. most people prefer to hold diversified portfolios of assets to undiversified portfolios of assets.
d. None of the above are correct.
ANS: D
Figure 4. The figure shows a utility function for Dexter.

Utility
C

A
$800

$1,300

$1,800

Wealth

41. Refer to Figure 4. In what way(s) does the graph differ from the usual case?
a. The utility function shown here is upward-sloping, whereas in the usual case the utility function is
downward-sloping.
b. The utility function shown here is bowed downward (convex), whereas in the usual case the utility
function is bowed upward (concave).
c. On the graph shown here, wealth is measured along the horizontal axis, whereas in the usual case
saving is measured along the horizontal axis.
d. On the graph shown here, utility is measured along the vertical axis, whereas in the usual case
satisfaction is measured along the vertical axis.
ANS: B
42. Refer to Figure 4. From the appearance of the graph, we know that
a. Dexters level of satisfaction increases by more when his wealth increases from $1,001 to $1,002
than it does when his wealth increases from $1,000 to $1,001.
b. Dexters level of satisfaction increases by less when his wealth increases from $1,001 to $1,002
than it does when his wealth increases from $1,000 to $1,001.
c. Dexters level of satisfaction increases by the same amount when his wealth increases from
$1,001 to $1,002 as it does when his wealth increases from $1,000 to $1,001.
d. None of the above answers can be inferred from the appearance of the utility function.
ANS: A
43. Refer to Figure 4. From the appearance of the utility function, we know that
a. Dexter is risk averse.
b. Dexter gains less satisfaction when his wealth increases by X dollars than he loses in satisfaction
when his wealth decreases by X dollars.
c. the property of diminishing marginal utility does not apply to Dexter.
d. All of the above are correct.
ANS: C
44. Refer to Figure 4. From the appearance of the utility function, we know that
a. Dexter is risk averse.
b. Dexter gains more satisfaction when his wealth increases by X dollars than he loses in satisfaction
when his wealth decreases by X dollars.
c. the property of decreasing marginal utility applies to Dexter.
d. All of the above are correct.
ANS: B
45. Refer to Figure 4. Suppose the vertical distance between the points (0, A) and (0, B) is 12. If his wealth
increased from $1,300 to $1,800, then
a. Dexters subjective measure of his well-being would increase by less than 12 units.
b. Dexters subjective measure of his well-being would increase by more than 12 units.
c. Dexter would change from being a risk-averse person into a person who is not risk averse.
d. Dexter would forgo the insurance he bought when his wealth was $1,300.

ANS:

46. Refer to Figure 4. Suppose Dexter begins with $1,300 in wealth. Starting from there,
a. the pain of losing $500 of his wealth would equal the pleasure of adding $500 to his wealth.
b. the pain of losing $500 of his wealth would exceed the pleasure of adding $500 to his wealth.
c. the pleasure of adding $500 to his wealth would exceed the pain of losing $500 of his wealth.
d. This cannot be determined from the graph.
ANS: C
47. From the standpoint of the economy as a whole, the role of insurance is
a. to entice risk-loving people to become risk averse.
b. to promote the phenomenon of adverse selection.
c. not to eliminate the risks inherent in life, but to spread them around more efficiently.
d. not to spread risks, but to eliminate them for individual policy holders.
ANS: C
48. The problem of moral hazard arises because
a. life is full of all sorts of risks.
b. after people buy insurance, they have less incentive to be careful about their risky behavior.
c. a high-risk person is more likely to apply for insurance than is a low-risk person.
d. insurance companies go to great effort to avoid paying claims to their policy holders.
ANS: B
49. As the number of stocks in a persons portfolio increases,
a. the risk of the portfolio increases, as indicated by the increasing value of the standard deviation of
the portfolio.
b. the risk of the portfolio increases, as indicated by the decreasing value of the standard deviation of
the portfolio.
c. the risk of the portfolio decreases, as indicated by the increasing value of the standard deviation of
the portfolio.
d. the risk of the portfolio decreases, as indicated by the decreasing value of the standard deviation
of the portfolio.
ANS: D
50. The largest reduction in a portfolios risk is achieved when the number of stocks in the portfolio is increased
from
a. 80 to 100.
b. 40 to 80.
c. 10 to 20.
d. 1 to 10.
ANS: D
51. Diversification of a portfolio
a. can eliminate market risk, but it cannot eliminate firm-specific risk.
b. can eliminate firm-specific risk, but it cannot eliminate market risk.
c. increases the portfolios standard deviation.
d. is not necessary for a person who is risk averse.
ANS: B
52. Mary Beth is risk averse and has $1,000 with which to make a financial investment. She has three options.
Option A is a risk-free government bond that pays 5 percent interest each year for two years. Option B is a
low-risk stock that analysts expect to be worth about $1,102.50 in two years. Option C is a high-risk stock
that is expected to be worth about $1,200 in four years. Mary Beth should choose
a. option A.
b. option B.
c. option C.
d. either A or B because they are the same to her.
ANS: A

53. A measure of the volatility of a variable is its

a. present value.
b. future value.
c. return.
d. standard deviation.
ANS: D
54. A risk-averse person
a. has a utility curve where the slope increases with wealth, and might take a bet with a 70 percent
chance of wining $400 and a 30 per chance of losing $400.
b. has a utility curve where the slope increases with wealth, and would never take a bet with a 70
percent chance of wining $400 and a 30 per cent chance of losing $400.
c. has a utility curve where the slope decreases with wealth, and might take a bet with a 70 percent
chance of wining $400 and a 30 per chance of losing $400.
d. has a utility curve where the slope decreases with wealth, and would never take a bet with a 70
percent chance of wining $400 and a 30 per cent chance of losing $400.
ANS: C
55. If a person is risk averse, then she has
a. diminishing marginal utility of wealth, implying that her utility function gets flatter as wealth
increases.
b. diminishing marginal utility of wealth, implying that her utility function gets steeper as wealth
increases.
c. increasing marginal utility of wealth, implying that her utility function gets flatter as wealth
increases.
d. increasing marginal utility of wealth, implying that her utility function gets steeper as wealth
increases.
ANS: A
56.If Robert is risk-averse, then he will always
a. choose not to play a game where he has a 50 percent chance of winning $1 and a 50 percent
chance of losing $1.
b. choose not to play a game where he has a 75 percent chance of winning $1 and a 25 percent
chance of losing $1.
c. choose to play a game where he has a 52 percent chance of winning $1 and a 48 percent chance
of losing $1.
d. All of the above are correct.
ANS: A
57. Which of the following games might a risk-averse person play?
a. a game where she has a 50 percent chance of winning $1 and a 50 percent chance of losing $1
b. a game where she has a 50 percent chance of winning $100 and a 50 percent chance of losing
$100
c. a game where she has a 60 percent chance of winning $1 and a 40 percent chance of losing $1
d. a game where she has a 40 percent chance of winning $1 and a 60 percent chance of losing $1
ANS: C
58. Which of the following games might a risk-averse person play?
a. a game where she has a 70 percent chance of winning $1 and a 30 percent chance of losing $1
b. a game where she has a 60 percent chance of winning $100 and a 40 percent chance of losing
$100
c. a game where she has a 60 percent chance of winning $2 and a 40 percent chance of losing $1
d. All of the above are correct.
ANS: D
59. Which of the following is correct concerning a risk-averse person?
a. She would not play games where the probability of winning and losing a dollar are the same.
b. She might not buy health insurance if she thinks her risks are low.
c. Her marginal utility of wealth decreases as her income increases.
d. All of the above are correct.
ANS: D

60. Svetlana is risk averse. Which of the following is correct about Svetlana?
a. Her marginal utility of wealth increases as her income increases.
b. She will always accept a bet if the probability of winning a dollar is the same as the probability of
losing a dollar.
c. Her utility function is a straight line.
d. None of the above are correct.
ANS: D
61. The utility function of a risk-averse person has a
a. positive slope and gets steeper as wealth increases.
b. positive slope but gets flatter as wealth increases.
c. negative slope but gets steeper as wealth increases.
d. negative slope and gets flatter as wealth increases.
ANS: B
62. A risk-averse person has
a. utility and marginal utility curves that slope upward.
b. utility and marginal utility curves that slope downward.
c. a utility curve that slopes down and a marginal utility curve that slopes upward.
d. a utility curve that slopes upward and a marginal utility curve that slopes downward.
ANS: D
63. Diminishing marginal utility of wealth implies that the utility function is
a. upward-sloping and has decreasing slope.
b. upward-sloping and has increasing slope.
c. downward-sloping and has decreasing slope.
d. downward-sloping and has increasing slope.
ANS: A
64. If a person is risk averse, then as wealth increases, total utility of wealth
a. increases at an increasing rate.
b. increases at a decreasing rate.
c. decreases at an increasing rate.
d. decreases at a decreasing rate.
ANS: B
65. Given that Tamar is a risk-averse person, she might accept a bet with a 50 percent chance of losing $100
today if she had a 50 percent
a. chance of winning $120 in two years and the interest rate was 11%.
b. chance of winning $114 in two years and the interest rate was 7%.
c. chance of winning $110 in two years and the interest rate was 3%.
d. None of the above are correct; a risk averse person would not accept any of the above bets.
ANS: C
66. Risk
a. can be reduced by placing a large number of small bets rather than a small number of large bets.
b. can be reduced by increasing the number of stocks in a portfolio.
c. Both A and B are correct.
d. Neither A nor B are correct.
ANS: C
Figure 5. On the graph, x represents risk and y represents return.
10 y
9
8
7
6
5
4
A
3
2
1

D
C
B

10

15

20

67. Refer to Figure 5. Point A represents a situation in which

ANS:

a.
b.
c.
d.

all of a persons savings are allocated to a class of safe assets.

the person knows with certainty that his or her return will be 3 percent.
the standard deviation of the persons portfolio is zero.
All of the above are correct.

68. Refer to Figure 5. Which of the following statements is correct?

a. At point A the standard deviation of the portfolio is 3.
b. A risk averse person always will choose to be at point A.
c. At point D the portfolio consists of about 15 percent stocks and 85 percent safe assets.
d. The figure shows that the greater the risk, the greater the return.
ANS: D
69. Diversification reduces
a. only market risk.
b. only firm-specific risk.
c. neither market or firm-specific risk.
d. both market and firm-specific risk.
ANS: B
70. Which of the following is a source of market risk?
a. Holding stocks in many companies carries the risk of a reduced average return.
b. Real GDP varies over time and sales and profits move with real GDP.
c. When a paper producer has declining sales, it is likely that so will other paper producers.
d. If stockholders become aggravated with the way a CEO runs a company, the price of that
companys stock might fall in the stock market.
ANS: B
71. There are many concerns for risk-averse lenders. Consider the following: 1. Lenders are concerned that
borrowers with the greatest risk are the ones most likely to actively pursue loans. 2. Lenders are concerned
that real GDP will decline leading to reduced corporate profits. 3. Lenders are concerned that products produced by certain corporations will become obsolete.
a. 1 is market risk; 2 is firm-specific risk
b. 2 is market risk; 3 is firm-specific risk
c. 3 is market risk; 1 is firm-specific risk
d. 2 is firm-specific risk; 3 is market risk
ANS: B
72. Which of the following is not correct?
a. A risk averse person might be willing to hold stocks.
b. Other things the same, a portfolio with the stocks of a large number of companies has less risk.
c. Other things the same, the larger a portion of savings a person invests in stocks, the greater his
expected return.
d. Diversification can eliminate market risk but not firm-specific risk.
ANS: D
73. An increase in the number of corporations in a portfolio from 1 to 10 reduces
a. market risk by more than an increase from 110 to 120.
b. market risk by less than an increase from 110 to 120.
c. firm-specific risk by more than an increase from 110 to 120.
d. firm-specific risk by less than an increase from 110 to 120.
ANS: C
74.
Angela reads financial advice columns and concludes the following. Which, if any, of her conclusions are
incorrect?
a. Higher average returns come at the price of higher risk.
b. People who are risk averse should never hold stock.
c. Diversification cannot eliminate all of the risk in stock portfolio.
d. None of her conclusions are incorrect.
ANS: B

75. Ben decided to increase the number of stocks in his portfolio. In doing so, Ben reduced
a. both the firm-specific risk and the market risk of his portfolio.
b. the firm-specific risk, but not the market risk of his portfolio.
c. the market risk, but not the firm-specific risk of his portfolio.
d. neither the market risk nor the firm-specific risk of his portfolio.
ANS: B
76. David increases the number of companies in which he holds stocks.
a. This reduces risk's standard deviation and firm-specific risk.
b. This reduces risk's standard deviation and market risk.
c. This raises market risk, but lowers firm-specific risk. What happens to overall risk is unclear.
d. This raises firm-specific risk, but lowers market risk. What happens to overall risk is unclear.
ANS: A
77.

Which of the following pairs of portfolios exemplifies the risk-return tradeoff?

For Portfolio A, the average return is 6 percent and the standard deviation is 15 percent; for
Portfolio B, the average return is 6 percent and the standard deviation is 25 percent.
b. For Portfolio A, the average return is 5 percent and the standard deviation is 15 percent; for
Portfolio B, the average return is 8 percent and the standard deviation is 15 percent.
c. For Portfolio A, the average return is 5 percent and the standard deviation is 25 percent; for
Portfolio B, the average return is 8 percent and the standard deviation is 15 percent.
d. For Portfolio A, the average return is 5 percent and the standard deviation is 15 percent; for
Portfolio B, the average return is 8 percent and the standard deviation is 25 percent.
ANS: D
a.

78. If stock prices follow a random walk, it means

a. long periods of declining prices are followed by long periods of rising prices.
b. the greater the number of consecutive days of price declines, the greater the probability prices
will increase the following day.
c. stock prices are unrelated to random events that shock the economy.
d. stock prices are just as likely to rise as to fall at any given time.
ANS: D
79. The efficient markets hypothesis says that
a. only individual investors can make money in the stock market.
b. it should be easy to find stocks whose price differs from their fundamental value.
c. stock prices follow a random walk.
d. All of the above are correct.
ANS: C
80. Suppose that interest rates unexpectedly rise and that Carter Corporation announces that revenues from
last quarter were down but not as much as the public had anticipated they would be down. According to the
efficient markets hypothesis, which of the these things make the price of Carter Corporation Stock fall?
a. both the interest rate rising and the revenue announcement
b. neither the interest rate rising nor the revenue announcement
c. only the interest rate rising
d. only the revenue announcement
ANS: C